MARGINAL COSTING

Introduction

This paper explores the use of cost accounting information for decision-making purposes.

DEFINITION OF KEY TERMS

Marginal cost: This is the cost of a unit of a product or service, which would be avoided if that unit or service was not produced or provided

Break-even point: This is the volume of sales where there is neither profit nor loss.

1 9 6 COST ACCOUNTING

S T U D Y T E X T

Margin of safety: This is the excess of sales over the break-even volume in sales. It states the extent to which sales can drop before losses begin to be incurred in a firm

Contribution: This is the difference between sales value and the marginal cost of sales.

To understand this topic, you need to understand the*…show more content…*

Before a firm can make a profit in any period, it must first of all cover its fixed costs.

MARGINAL AND ABSORPTION COSTING

1 9 8 COST ACCS T U D Y T E X T

Suppose that a firm makes and sells a single product that has a marginal cost of Shs.25 per unit and that sells for Shs.40 per unit. For every additional unit of the product that is made and sold, the firm will incur an extra cost of Shs.25 and receive income of Shs.40. The net gain will be

Shs.15 per additional unit. This net gain per unit is called contribution

Contribution per Unit = Sales – variable costs

= Shs.40 – Shs.25

= Shs.15

The Principles of Marginal Costing

The principles of marginal costing are as follows:

Period fixed costs are the same, for any volume of sales and production (provided that the level of activity is within the ‘relevant range’). Therefore, by selling an extra item of product or service the following will happen:

Ø Revenue will increase by the sales value of the item sold,

Ø Costs will increase by the variable cost per unit,

Ø Profit will increase by the amount of contribution earned from the extra item.

Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item.

Profit measurement should, therefore, be based on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge

Introduction

This paper explores the use of cost accounting information for decision-making purposes.

DEFINITION OF KEY TERMS

Marginal cost: This is the cost of a unit of a product or service, which would be avoided if that unit or service was not produced or provided

Break-even point: This is the volume of sales where there is neither profit nor loss.

1 9 6 COST ACCOUNTING

S T U D Y T E X T

Margin of safety: This is the excess of sales over the break-even volume in sales. It states the extent to which sales can drop before losses begin to be incurred in a firm

Contribution: This is the difference between sales value and the marginal cost of sales.

To understand this topic, you need to understand the

Before a firm can make a profit in any period, it must first of all cover its fixed costs.

MARGINAL AND ABSORPTION COSTING

1 9 8 COST ACCS T U D Y T E X T

Suppose that a firm makes and sells a single product that has a marginal cost of Shs.25 per unit and that sells for Shs.40 per unit. For every additional unit of the product that is made and sold, the firm will incur an extra cost of Shs.25 and receive income of Shs.40. The net gain will be

Shs.15 per additional unit. This net gain per unit is called contribution

Contribution per Unit = Sales – variable costs

= Shs.40 – Shs.25

= Shs.15

The Principles of Marginal Costing

The principles of marginal costing are as follows:

Period fixed costs are the same, for any volume of sales and production (provided that the level of activity is within the ‘relevant range’). Therefore, by selling an extra item of product or service the following will happen:

Ø Revenue will increase by the sales value of the item sold,

Ø Costs will increase by the variable cost per unit,

Ø Profit will increase by the amount of contribution earned from the extra item.

Similarly, if the volume of sales falls by one item, the profit will fall by the amount of contribution earned from the item.

Profit measurement should, therefore, be based on an analysis of total contribution. Since fixed costs relate to a period of time, and do not change with increases or decreases in sales volume, it is misleading to charge

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